Yale University's endowment has offered a rebuttal to Warren Buffett and other proponents of low-fee, passive investments.

In its 2017 annual report, released this week, the Ivy League school's investment office argued in favor of the active management strategies long employed by chief investment officer David Swensen and his staff. The top ten U.S. university endowments "amaze," Yale said in the report. "Their well-diversified portfolios crush the returns produced by U.S. stocks."

The argument came in response to Buffett's 2016 investor letter, which suggested that endowments and other institutional investors would be better off investing in the Standard & Poor's 500 index.

For the 20-year period ending June 30, Yale's endowment earned a 12.1 percent annualized return, beating its benchmark Wilshire 5000 stock index, which gained 7.5 percent. A passive portfolio with a 60 percent stock allocation and 40 percent in bonds, meanwhile, had a 20-year return of 6.9 percent.

Scalability. Yale has a $27B endowment. It’s large, but not massive. It’s growth is limited because it doesn’t take outside investors, and the only infusions of capital are Yale’s budget surplus and reinvested endowment earnings. As a investment vehicle grows, it returns will slow down. Vanguard has $5T, 185x that of Yale’s AUM. Even Berkshire Hathaway’s annual returns have shrunk as the vehicle itself as grown due to WB being unable to find enough places to allocate his capital, and in the long run will eventually converge with the S&P 500 (hence, a cynic would say is the reason for WB’s championing index funds now.)

Fees. Yale has been able to hold down fund manager compensation and pays far less than the 2-and-20 standard on the street (although princely packages compared to professor compensation). But you can bet that any retail investor who plough into such a structure will be buying their fund managers yachts.

Taxes. Yale is a 501(c)3. They don’t pay any taxes on reallocations, rebalancing, etc.

Stability. Yale is a university. It draws maybe 3-5% from its endowment every year, year in and year out. It is older than the republic and has seen its share of downturns. As a sole shareholder, it will not “panic” and make mass withdrawals in downturns. As a result, the fund needs to keep a very predictable, very regular, and very small portion of its assets in liquid form.

Access. Yale is not investing entirely in a portfolio of public equities. In public markets, the ability to access management both for information and to have a hand in governance is next to nonexistent. In private equity investing, good managers can actually add value to their own investment by participating in governance.

Finally, I don’t believe Warren said that passive always beats active. I believe Warren said the “active” that is accessible by ordinary retail investors (high fees, few information or governance rights, tax inefficient) is unlikely to outperform passive over the long term due to these structural headwinds — and if they do, they are even less likely to repeat that performance for another period. The “active investment management” that is accessible to large institutions (esp nonprofits) have structural advantages versus the mutual funds you can buy off Edward Jones.

So, yes, Yale can crush stock indices. However, you are not Yale. You do not have access to the same investing opportunities as does Yale. You do not have the same tax advantages as does Yale. So therefore, you are far less likely to be able to “crush” those stock indices as is Yale, as Yale’s tailwinds are your headwinds. And anyone who claims they can give you the same advantages as Yale for the low, low price of 2% of assets under management, and 20% of gains over a benchmark, is full of stercus vaccae.

Last edited by Badger1754 on Sun Apr 15, 2018 3:19 pm, edited 9 times in total.

Yale should use past tense for the claim. They've only generated an annual return of around 8% in the last 10 years, vs 9.7% for US stocks.

Not taking sides, but are you asserting that short term returns provide better data than long term returns?

Could also mean arbitrary starting points is a problem. An average of 10-year rolling returns could be most telling.

Yeh, it could -- but that wouldn't be my default assumption. In lieu of the rolling returns, I'd take the 30-year returns over the last 10 years, especially when comparing anything to stock returns which have been abnormally high over the last decade.

May you have the hindsight to know where you've been, The foresight to know where you're going, And the insight to know when you've gone too far. ~ Irish Blessing

I have heard David Swenson say much the same thing as Buffet. Swenson stated average person on the street cannot and should not try to replicate the Yale investment fund. They should stick to Stock index funds and treassury and tips bonds, 70% stocks 15% treasury bonds and 15% tips. I question the percentage of endowment funds that can beat 60/40 combination of the Vanguard total stock market fund and the Vanguard intermediate treasury fund.

"The endowment sets performance hurdles for each investment strategy and “structures its partnerships so incentive fees are only paid when external partners outperform their benchmarks on a net basis.”"

I suppose it's not surprising, but has anyone questioned how they managed to absolutely trounce the TSM over a 20 year period? Was it through a superior allocation to specific asset classes, was it through stock picking, was it through market timing, etc.?

They give broad sweeping views of this without a lot of specifics, of course.

Yale's endowment, for instance, said it had 75.1 percent of its portfolio invested in alternatives in June, including a 25.1 percent "absolute return" allocation and 17.1 percent commitment to venture capital. Leveraged buyout funds made up 14.2 percent of the portfolio, while real estate investments accounted for 10.9 percent. Only 3.9 percent of the endowment was invested in domestic equities, well below the average university endowment's 20.7 percent allocation.

75% in alternatives is huge. Fewer than 4% in domestic equities was a shocker to me. I have no doubt that one can far outperform stocks with venture capital if one has the necessary skill, but that's a very active strategy indeed, certainly not something available to the lion's share of investors or even institutions.

I suppose the real question is whether they'll be able to duplicate this feat for the next 20 years. I doubt that this performance was a complete fluke, though, and unlike many here, I wouldn't write it off as such.

“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings

"The endowment sets performance hurdles for each investment strategy and “structures its partnerships so incentive fees are only paid when external partners outperform their benchmarks on a net basis.”"

Therefore, the unrealized return can be whatever you need to beat the benchmark and to get the incentive fee.

If you're looking at individual cases, it is absolutely the case that some active investors beat passive. Buffett himself is an example. It is also absolutely true that the aggregate of active investors can't beat themselves.
The distribution of active 'winners' vs 'losers' is skewed. Whether it's through skill or luck, there tends to be very few 'winners'.

"To achieve satisfactory investment results is easier than most people realize; to achieve superior results is harder than it looks." - Benjamin Graham

I pretty much discounted anything said in the article after reading the first line:

"Yale University's endowment has offered a rebuttal to Warren Buffett and other proponents of low-fee, passive investments."

Obviously, the author missed the point. If Buffett's argument was that no one could ever beat a passive index, then Buffett would be his own rebuttal.

You should have read more than the first line.

You don't even know what Buffet's argument was and are making up a strawman. Buffet said that university endowments would be better off investing 100% in the S&P 500. The entire "argument" between Swensen and Buffet is about university endowments, not anything else.

Much of Yale's holdings are in illiquid assets that rarely trade. The valuation must involve a good deal of estimation. I wonder how reliable their reported returns and performance actually are.

That's what I've been saying for years. If there is no market price, then you use a model price. With the right model and assumptions, the model price can be anything you want it to be.

You might enjoy the paper "Replicating Private Equity with Value Investing, Homemade Leverage, and Hold-to-Maturity Accounting" by Erik Stafford. He says that you don't even need to use a model price. By using hold-to-maturity accounting the measured risk goes away. (This is largely the difference between a bond fund vs. a bond ladder as well.)

Private equity funds tend to select relatively small firms with low EBITDA multiples. Publicly traded equities with these characteristics have high risk-adjusted returns after controlling for common factors typically associated with value stocks. Hold-to-maturity accounting of portfolio net asset value eliminates the majority of measured risk. A passive portfolio of small, low EBITDA multiple stocks with modest amounts of leverage and hold-to-maturity accounting of net asset value produces an unconditional return distribution that is highly consistent with that of the pre-fee aggregate private equity index. The passive replicating strategy represents an economically large improvement in risk- and liquidity-adjusted returns over direct allocations to private equity funds, which charge average fees of 6% per year.

Vanguard Balanced Index Admiral shares returned almost 14% in calendar 2017. The geniuses at Harvard returned 8.1% in their FY 2017. The largest endowment fund in the world, and my backdoor Roth outperformed it in percentage terms. The point is that much of the time (not all), the simple index approach works out quite well and is the best approach for the average investor. No need to try to get clever.

Much of Yale's holdings are in illiquid assets that rarely trade. The valuation must involve a good deal of estimation. I wonder how reliable their reported returns and performance actually are.

This is an important point, and it applies to more than just Yale.

It also appears that reporting requirements have changed. A few years back, all of the investment assets were categorized as level 1, 2, or 3 (categories relating to whether there were market prices, or just estimates) and now it seems as though 3/4 of their assets escape categorization. I don't keep up with this stuff that closely, but it is a change in presentation.

I suppose it's not surprising, but has anyone questioned how they managed to absolutely trounce the TSM over a 20 year period? Was it through a superior allocation to specific asset classes, was it through stock picking, was it through market timing, etc.?

They use a portfolio constructed with principles of modern portfolio theory from some traditional institutional assets like equities, bonds, and commercial real estate, as well as alternative investments like timber land, private equity and hedge funds. They also try to boost returns by capturing a liquidity risk premium from illiquid private equity investments by managing liquidity to their projected portfolio outflows.

Their superior returns from 1998 until about the end of 2007 relative to equities were from having a low allocation to equities over a period when market returns were low. They had low exposure to the tech bubble and its unwinding before and after year 2000. On the other hand, the 2008/2009 market crisis and its aftermath were not as kind to the Yale portfolio.

I pretty much discounted anything said in the article after reading the first line:

"Yale University's endowment has offered a rebuttal to Warren Buffett and other proponents of low-fee, passive investments."

Obviously, the author missed the point. If Buffett's argument was that no one could ever beat a passive index, then Buffett would be his own rebuttal.

You should have read more than the first line.

You don't even know what Buffet's argument was and are making up a strawman. Buffet said that university endowments would be better off investing 100% in the S&P 500. The entire "argument" between Swensen and Buffet is about university endowments, not anything else.

I did read the entire article and found it lacking in details that would help to explain why or if the Yale endowment did outperform the overall market over the last 30 years. The first line did color my reading of the rest of the article. Also influencing my reading was that the article is published in a trade journal for institutional investors that likely receives significant advertising dollars from high-fee active funds.

As for knowing what Buffett's argument is, I'm no expert, but I read his shareholder letters and feel that I understand the gist of what he is saying - that institutional managers are reluctant to invest in index funds because they are swayed by the allure of high fee esoteric alternative investments just like retail investors are often swayed by high fee actively managed mutual funds, even though in aggregate these active funds underperform index funds due to the high fees. However, he is also very explicit in stating that individual managers and investors can outperform the market; in aggregate, they won't. That was simply the point I was trying to make. I was not setting up any type of straw man or even arguing for any point of view (other than to criticize the lack of details in the article). Buffett could be totally wrong, as could Swensen. They could both be wrong.

I do think the argument is about more than university endowments. The argument is about the fund management industry in general.

Cherry picking dates helps a lot. The last 20 years starting after 2017 began in Jan. 1998, near the end of the dot com boom in stocks which totally collapsed in March of 2000. The 20 year period chosen for comparison included just the tail end of the tech market skyrocket but it did include all of the 2 worst bear markets for stocks since the Great Depression (2000-3, 2007-9), and the "lost decade" for equities following the later collapse. It was a time period when alternate investments not correlated to the markets including private equity, real estate, hedge funds, distressed debt plays, astute options action, etc., had a real opportunity to outperform the markets if properly executed. Swenson, the poster boy for endowment success, did well in this setting although in recent years as market turmoil slowly abated, he has significantly underperformed the market. You don't decide if a strategy works by comparing its extreme performer during a rocky two decades to stocks (who in this case are not available to average investors anyway) but rather how the average performer did. I don't know the figures but I suspect that the average college endowment likely underperformed both the market and a balanced portfolio at a similar risk level even over this unfavorable time period for US equities. It is exceptionally easy to pick past winners in hindsight, very difficult to do so for the future. Finding active management past winners relative to low cost indexes over almost any time frame is child's play, incredibly easy. That does not prove that active management is a better choice for investors. Whether that will translate into the future is entirely unknown. Warren Buffett knows something about creating alpha. He has done it for a very long time. When he advises investors toward low cost broadly diversified index funds I prefer to listen to him rather than those touting complex and expensive investment approaches.

Shouldn't it be more accurate to compare return on a post tax basis? 12% return YoY at the highest tax bracket doesn't sound very nice. I imagine there's a lot of trading that would exclude Yale from long term capital gains tax rate.

I suppose it's not surprising, but has anyone questioned how they managed to absolutely trounce the TSM over a 20 year period? Was it through a superior allocation to specific asset classes, was it through stock picking, was it through market timing, etc.?

From people who have studied it, the evidence is not so much asset allocation as in Yale's skill at picking top quartile managers. They were also early to Alternative Asset classes (which would support the first view).

They give broad sweeping views of this without a lot of specifics, of course.

Yale's endowment, for instance, said it had 75.1 percent of its portfolio invested in alternatives in June, including a 25.1 percent "absolute return" allocation and 17.1 percent commitment to venture capital. Leveraged buyout funds made up 14.2 percent of the portfolio, while real estate investments accounted for 10.9 percent. Only 3.9 percent of the endowment was invested in domestic equities, well below the average university endowment's 20.7 percent allocation.

75% in alternatives is huge. Fewer than 4% in domestic equities was a shocker to me. I have no doubt that one can far outperform stocks with venture capital if one has the necessary skill, but that's a very active strategy indeed, certainly not something available to the lion's share of investors or even institutions.

Yale's job is not to outperform in VC. It's to pick the funds that will outperform. Swensen takes you through the data in one of his 2 books-- the odds are really against being able to do that. There is a very small number of firms (Kleiner Perkins, et al) that consistently outperform the Nasdaq. To become a Limited Partner in those funds, now, is invitation only.

By contrast, generally, VC funds underperform-- the skew is much worse than in PE/ LBO funds generally. The Kaufman Foundation report on VC investing was quite depressing in this regard.

Yales's skill is in picking the best alternative asset managers - he gives some idea of what he looks for in his books. However successful managers have finite capacity for more capital.

I suppose the real question is whether they'll be able to duplicate this feat for the next 20 years. I doubt that this performance was a complete fluke, though, and unlike many here, I wouldn't write it off as such.

Usual problems:

- size counts against you, you fade towards the average return. You need bigger and bigger commitments to funds to get the same effect on portfolio value

- David Swensen is not immortal, and has had cancer (not sure of his status now). Thus, you are reliant on the transfer of magic to "the team". There's a pretty poor record of asset managers doing that.

Much of Yale's holdings are in illiquid assets that rarely trade. The valuation must involve a good deal of estimation. I wonder how reliable their reported returns and performance actually are.

This is an important point, and it applies to more than just Yale.

It also appears that reporting requirements have changed. A few years back, all of the investment assets were categorized as level 1, 2, or 3 (categories relating to whether there were market prices, or just estimates) and now it seems as though 3/4 of their assets escape categorization. I don't keep up with this stuff that closely, but it is a change in presentation.

However in the end Alternative Assets are cash-to-cash because of the finite life of the constituent funds.

The funds typically have a life of 10 years, after which the residual assets are resolved and the remaining proceeds given back to LPs (ie Yale & others), and the GP (effectively the fund manager) winds up the Partnership. There will have been returns throughout the life of the funds.

So Yale could be overstating the value of its funds, where there are unrealized investments in those funds. However eventually the value will converge on the true cash value. Only if they keep putting more money into funds, at overstated valuations for unrealized investments, will this lead to an unrealistic overstatement of value - in equilibrium with cash in to the portfolio = cash out, the valuations will be on average correct.

With Real Estate funds I don't have too much worry. There's industry accepted benchmarks for valuing buildings-- the fund unit values are unlikely to be more than 12 months out from market value.

Cherry picking dates helps a lot. The last 20 years starting after 2017 began in Jan. 1998, near the end of the dot com boom in stocks which totally collapsed in March of 2000. The 20 year period chosen for comparison included just the tail end of the tech market skyrocket but it did include all of the 2 worst bear markets for stocks since the Great Depression (2000-3, 2007-9), and the "lost decade" for equities following the later collapse.

I'd argue since it included both bull and bear markets, it wasn't a bad time to make that comparison although from 1990 would of course have been better. The usual problem is the reverse: equity returns since 1980 have been about the highest they have ever been for a historical period (I'd have to check that - -certainly they were 1980-2000, but not sure 1980-2017) and that makes quoted equities look better than they probably will be in the future. Bonds of course have the same problem-- this really must be the best 38 years for bonds ever recorded!

It was a time period when alternate investments not correlated to the markets including private equity, real estate, hedge funds, distressed debt plays, astute options action, etc., had a real opportunity to outperform the markets if properly executed. Swenson, the poster boy for endowment success, did well in this setting although in recent years as market turmoil slowly abated, he has significantly underperformed the market.

Some of those alternative assets have strong quoted market correlations in the long run- -they only look uncorrelated on a yearly basis.

The main issues, as always, are finding the right managers. For example pure shorts are a losing bet in the long run (markets go up). But the right pure shorts make a lot of money-- the funds that do that are long term survivors.

You don't decide if a strategy works by comparing its extreme performer during a rocky two decades to stocks (who in this case are not available to average investors anyway) but rather how the average performer did. I don't know the figures but I suspect that the average college endowment likely underperformed both the market and a balanced portfolio at a similar risk level even over this unfavorable time period for US equities.

Swensen has said that unless you have unusual skill in picking fund managers, an indexed approach is best (for endowments).

It is exceptionally easy to pick past winners in hindsight, very difficult to do so for the future. Finding active management past winners relative to low cost indexes over almost any time frame is child's play, incredibly easy. That does not prove that active management is a better choice for investors. Whether that will translate into the future is entirely unknown. Warren Buffett knows something about creating alpha. He has done it for a very long time. When he advises investors toward low cost broadly diversified index funds I prefer to listen to him rather than those touting complex and expensive investment approaches.

Garland Whizzer

William Bernstein had a piece on Buffett and Swensen. Great fund managers are as rare as Nobel prize winning scientists, great athletes etc. It is human nature that most of us are average, and some of us are exceptional-- almost no one is exceptional in many areas*, most truly exceptional people are so in 1 or 2 areas. Oddly, in fund management, they don't do it for the money. Swensen is hugely underpaid by Wall Street standards (by a factor of 10x at least) and Buffett is famous for never spending any money personally-- it wasn't until Bill & Melinda Gates, who he trusts via playing bridge together, that he found a way do deploy that capital on spending, rather than reinvesting it.

Buffett is a great fund manager. For whom we have the longest public track record, probably the greatest. And as he says, it's all down to Charlie Munger . Buffett makes direct investments into companies. Quoted companies earlier in his career and now mostly purchases of entire private cos. 3G partners (Heinz and Kraft) is probably as close as Buffett gets to a Fund-of-Funds approach.

Over to Swensen. He's a Fund-of-Funds guy. He has 2 levers:

- asset allocation - long term view on the right asset classes

- fund manager selection

The research on Yale that I have seen is that it is latter that matters for their performance. But also that they got the move out of quoted equities and into alternative asset classes early and right.

* Richard Feynman would be an exception. Carl Sagan perhaps. Winston Churchill was something of a polymath, although tended to overextend himself badly (micromanagement of military-strategic issues).

Churchill was, in fact, a disaster area when it came to personal finance. Kept afloat by benefactors and some highly unorthodox "deals" with Inland Revenue (they would bring a politician down, now, if ever revealed).

I struggle to name many others.

Ahh.. John Maynard Keynes. He was an extraordinary polymath. A great economist. But also man of the arts. Successful fund manager on behalf of his college - the original endowment manager .

So Yale could be overstating the value of its funds, where there are unrealized investments in those funds. However eventually the value will converge on the true cash value. Only if they keep putting more money into funds, at overstated valuations for unrealized investments, will this lead to an unrealistic overstatement of value - in equilibrium with cash in to the portfolio = cash out, the valuations will be on average correct.

I found the rule change that has resulted in the reporting change that I noted. If you look at their 2014 financial statements, you can see that about 20B of 29B in assets were classified as "level 3", meaning that the valuation of those assets involved a great deal of estimation. Beginning in 2015, only a small subset of assets was subject to the level 1,2,3, classification, while the vast remainder is simply presented as net asset value (NAV). This resulted from accounting standards update 2015-07. I can't say that I'm up to date on these issues, but its clear from the before and after that a potential red flag was removed for three quarters of their assets. (Again, its important to note that this isn't just Yale, its everybody who runs large investment funds that invest in illiquid investments.)

My fear is that it puts the valuation issues into the hands of the general partners who run the funds and their auditors and appraisers, and in a way that could lead to some surprises down the road. We can only hope that does not turn out to be the case.

"The endowment sets performance hurdles for each investment strategy and “structures its partnerships so incentive fees are only paid when external partners outperform their benchmarks on a net basis.”"

Sounds good when you hear it, but in actuality, it's just a form of momentum investing with survival bias. You get entangled in firms that take extraordinary risk to meet the high bars and those that succeed, either by skill or luck, get to play another round, while those that fail drop out.

I was trying to recall a larger retirement fund that went all passive, but can't find it again. If you know of what I'm talking about, please let me know. I've come to the same thinking that most college endowments should probably just go passive and save all those fees along with retirement plans (e.g. state and public workers). If they must, put an allocation to non public funds, and track the performance, but avoid hedge funds and active funds that compete in the public markets.

Recent post at markovprocesses.com suggests that the Yale Portfolio returns could have been achieved with a 60/40 portfolio leveraged at 40%... for less risk than Yale took on. I had trouble copying in the link, but it is also at Abnormalreturns.com, Friday's post (4/13/18).

Recent post at markovprocesses.com suggests that the Yale Portfolio returns could have been achieved with a 60/40 portfolio leveraged at 40%... for less risk than Yale took on. I had trouble copying in the link, but it is also at Abnormalreturns.com, Friday's post (4/13/18).

For the last 10 years 60/40 WITHOUT leveRage would have done it. Vanguard balanced index was Cagr of 6.6% same as the Yale endowment.

Is eluding avoiding or evading? Looks like some colleges and universities will be looking for ways to (legally) not fall under this new law, including spending down their endowments or increasing vs reducing the enrollments, especially if they're right on the border. They're going to have to start doing more of what we do here at BH. It could lead to reorganizations including mergers or breakups of endowments or corresponding organizations so as not to fall under this requirement. Will Yale (and others subject to this tax) be able to overcome the 1.4% handicap going forward? Or are we looking at the returns all wrong to consider taxes?

Absolute returns are what investments do, while after tax returns depend on the investor. And you have other costs that vary as well.

Last edited by inbox788 on Mon Apr 16, 2018 12:03 pm, edited 1 time in total.

So Yale could be overstating the value of its funds, where there are unrealized investments in those funds. However eventually the value will converge on the true cash value. Only if they keep putting more money into funds, at overstated valuations for unrealized investments, will this lead to an unrealistic overstatement of value - in equilibrium with cash in to the portfolio = cash out, the valuations will be on average correct.

I found the rule change that has resulted in the reporting change that I noted. If you look at their 2014 financial statements, you can see that about 20B of 29B in assets were classified as "level 3", meaning that the valuation of those assets involved a great deal of estimation. Beginning in 2015, only a small subset of assets was subject to the level 1,2,3, classification, while the vast remainder is simply presented as net asset value (NAV). This resulted from accounting standards update 2015-07. I can't say that I'm up to date on these issues, but its clear from the before and after that a potential red flag was removed for three quarters of their assets. (Again, its important to note that this isn't just Yale, its everybody who runs large investment funds that invest in illiquid investments.)

My fear is that it puts the valuation issues into the hands of the general partners who run the funds and their auditors and appraisers, and in a way that could lead to some surprises down the road. We can only hope that does not turn out to be the case.

Ahh yes. Thank you.

If subsequently the GPs have been systematically overstating values, then things will look pretty well since 2014, and that could come home to roost.

There's an issue with doing that, if you are GP. There exist Fund Secondary buyers (Coller Capital in Europe, I know Paul Capital Partners in USA) who buy units in funds e.g. when a pension fund or endowment needs to generate liquidity quickly before the actual windup of the fund. I am guessing that funds change hands more or less at NAV per unit.

If there is significant overstatement then the sellers are winning, and the secondary funds buying are getting done over. And that will lead to litigation against the GPs & their auditors.

So the risk is there, and it's real, but the GPs cannot operate with a completely free hand. On the other hand, the Yale team itself might have an incentive not to query NAVs too hard, depending on how their compensation is structured. It was annual bonuses that made creating and flogging CDOs so lucrative and attractive for investment bankers, to the detriment of their firms and their clients.

I can see a risk there and it's hard to quantify it. You see people like the Canadian public pension funds going all in for direct PE investing (ie not through a fund) and there's an incentive (their own bonus schemes) to hold at unrealistic values. And that's significant money (billions).

If we could get a sense at the premium/ discount to NAV Fund Secondary buyers are paying then that might give us a sense of the risk.

Not just Yale that outperformed so different active strategies may be involved other than Swensen's (not to mention Berkshire, which is also actively managed).

This cohort includes Princeton University and Massachusetts Institute of Technology, each led by Yale endowment alums, as well as Duke University and the University of Virginia.

I think the point of the article is that institutional investors who can employ sophisticated financial strategies can beat passive equity-centric strategies consistently over long periods of time. Also note, that institutional investors invest based on an infinite time horizon. Individual investors don't have access to these management strategies (with the exception of buying BRK), and they cannot assume an infinite investment horizon, so they are better off with low-cost index strategies. The article was critical of Buffett's assertion that institutional investors would be better off using passive equity-centric strategies. Of course, if Buffett is right then Swensen and a bunch of other high-paid institutional investment executives are out of a job so it would be in their best interest if he's not. At any rate, it's all pretty much irrelevant to us individual investors.

May you have the hindsight to know where you've been, The foresight to know where you're going, And the insight to know when you've gone too far. ~ Irish Blessing

Recent post at markovprocesses.com suggests that the Yale Portfolio returns could have been achieved with a 60/40 portfolio leveraged at 40%... for less risk than Yale took on. I had trouble copying in the link, but it is also at Abnormalreturns.com, Friday's post (4/13/18).

For the last 10 years 60/40 WITHOUT leveRage would have done it. Vanguard balanced index was Cagr of 6.6% same as the Yale endowment.

Vanguard balanced index is a US only stock/bond fund. Is the suggestion that Yale should invest 100% in US allocation and no international?

What Does Nevada’s $35 Billion Fund Manager Do All Day? Nothing
Nevada goes passive to beat peers; BLT or tuna

Mr. Edmundson, 44 years old, has until recently been a pension-world outlier. Other state retirement systems turned to complicated investments and costly money managers to try to outperform markets with algorithms and smarts.

His strategy is to keep costs low and not try beating markets, he says. “We’re bare bones.”

Recent post at markovprocesses.com suggests that the Yale Portfolio returns could have been achieved with a 60/40 portfolio leveraged at 40%... for less risk than Yale took on. I had trouble copying in the link, but it is also at Abnormalreturns.com, Friday's post (4/13/18).

For the last 10 years 60/40 WITHOUT leveRage would have done it. Vanguard balanced index was Cagr of 6.6% same as the Yale endowment.

Vanguard balanced index is a US only stock/bond fund. Is the suggestion that Yale should invest 100% in US allocation and no international?

It is a legitimate benchmark. But VSMGX, Vanguard LifeStrategy Moderate (60/40 with sizable allocations to non-US equities and bonds) has delivered a CAGR of 6% over the last 10 years and they didn't crush that over the last 10 years either.

The Yale portfolio is only 20% bonds, so VASGX LifeStrategy Growth is probably a fairer comparison. It delivered a CAGR of 6.5% the last 10 years. Considering that is not even an admiral share class, and endowments invwdt at institutional levels, the 10 bp lag in return would not really be a lag at all.

But it turns out costs are a much bigger conundrum in the comparisons. Many endowments do not calculate investment returns net of the administrative cost of having an entire investment management department. The department may just be funded in the university budget. Even performance incentive bonuses paid to hedge funds and private equity funds may not be netted out of gross returns when calculating investment returns:

Endowments invest (at least are modeled to invest) in perpetuity. No individual can.

One obvious source of return available to perpetual investors is from illiquid assets. Probably neither you nor I could see the sense, for example, in buying some depleted forestland, planting trees, waiting for forty years, then starting a sustainable harvest and replant program. In the mean time, transaction costs to sell the partially-redeveloped forest might be prohibitive.

Endowments could see the sense in it.

If I may furthermore ask, what if the Yale endowment hadn't "crushed" stock indexes? What would happen to the people who work there, if Yale might as well run its own total-market index fund for itself?

Is the total stock market an appropriate benchmark for Yale's endowment?

If Yale hadn't achieved a higher return than total stock market, would it word its annual report that way? How would it word it?

Do high-level Yale employees not understand the difference between verb tenses?

Is this a case of survivorship bias, not with respect to funds but instead the continued employment of Yale's investment managers?

Much of Yale's holdings are in illiquid assets that rarely trade. The valuation must involve a good deal of estimation. I wonder how reliable their reported returns and performance actually are.

I once raised that point to the head of a large endowment. He would not look me in the eye, mumbled something about best estimates and clearly did not want to talk about it

That said, over the long term it could be tricky to game the returns of illiquid assets. One would end up with vastly greater reported than realized valuation. That could get embarrassing when one had to rebalance and could not find buyers at the stated value. I suppose one could sell off the most marketable holdings and let the most overvalued stay in the portfolio forever....

One could certainly smooth the estimated values of the illiquid assets, pretending they are far less volatile than reality. That would make the Sharpe ratios look great and never get caught.

I do believe a huge endowment could at least in theory capture some premiums for holding illiquid investments. Since they are not marked to market every day, no one knows the risk adjusted return.

Interesting that they even brought up the alternative of passive investing. This suggests the message may be getting to the Yale trustees and they may be applying pressure on the managers.

We don't know how to beat the market on a risk-adjusted basis, and we don't know anyone that does know either |
--Swedroe |
We assume that markets are efficient, that prices are right |
--Fama

Much of Yale's holdings are in illiquid assets that rarely trade. The valuation must involve a good deal of estimation. I wonder how reliable their reported returns and performance actually are.

I once raised that point to the head of a large endowment. He would not look me in the eye, mumbled something about best estimates and clearly did not want to talk about it

That said, over the long term it could be tricky to game the returns of illiquid assets. One would end up with vastly greater reported than realized valuation. That could get embarrassing when one had to rebalance and could not find buyers at the stated value. I suppose one could sell off the most marketable holdings and let the most overvalued stay in the portfolio forever....

That's precisely the point. 3rd party alternative asset managers usually are structured as Limited Partnerships, with a 10 year life (that's the norm in Private Equity, and, I believe, in Real Estate; Infrastructure would have to be longer). After 10 years, the LPs may vote up to 2 x1 year extensions (to prevent distributions of holdings in specie ie as stock not cash). The Commitment Period is normally 5 years-- after that, the LPs are only liable for drawdowns for existing portfolio cos (usually there is some restriction like 10% of Committed Capital).

Thus, if the assets are overvalued, the cash returns won't meet those NAV estimates. At the end of 10 years, the 2 numbers have to meet up== they must be equal at the end of the fund life, because all assets have been turned into cash and sold.

There are realized and unrealized IRRs. The former are cash-to-cash, the latter use the values of unrealized assets.

One could certainly smooth the estimated values of the illiquid assets, pretending they are far less volatile than reality. That would make the Sharpe ratios look great and never get caught.

Yes. But one would get caught eventually in one's performance reporting.

The interesting one is 17% in Venture Capital. That's absolutely huge for an asset class where the performance dispersion between managers is astronomic - Swensen in one of his books talks this through. A handful of partnerships reap all the excess returns to the asset class.

Is this a consequence of investing a lot of cash into that asset class, or the result of very high reported returns? the Unicorns may well be overvalued, and therefore the final cash-to-cash returns may be lower. But that's a consequence of the way Unicorns are valued - at the value imputed by the last funding round. Late stage VC in particular at the moment is very frothy-- Uber's $59bn valuation (I think the Softbank round was actually done at less than that). We'll see if people actually get cash exits at those values.

I do believe a huge endowment could at least in theory capture some premiums for holding illiquid investments. Since they are not marked to market every day, no one knows the risk adjusted return.

Interesting that they even brought up the alternative of passive investing. This suggests the message may be getting to the Yale trustees and they may be applying pressure on the managers.

They have some of the best finance professors in the world on their faculty. I'd be surprised if they were not consulted.

Scalability. Yale has a $27B endowment. It’s large, but not massive. It’s growth is limited because it doesn’t take outside investors, and the only infusions of capital are Yale’s budget surplus and reinvested endowment earnings. As a investment vehicle grows, it returns will slow down. Vanguard has $5T, 185x that of Yale’s AUM. Even Berkshire Hathaway’s annual returns have shrunk as the vehicle itself as grown due to WB being unable to find enough places to allocate his capital, and in the long run will eventually converge with the S&P 500 (hence, a cynic would say is the reason for WB’s championing index funds now.)

AFAIK there are US tax rules re minimum drawdown (and this has changed with the new tax act, for very large endowments). About 1/3rd of the budget of Yale University has come from its Endowment (that was a number from a few years back, when I last looked at it). There's no university surplus to put into it.

$27bn portfolio is a pretty big one in the institutional investing world.

[*]Fees. Yale has been able to hold down fund manager compensation and pays far less than the 2-and-20 standard on the street (although princely packages compared to professor compensation). But you can bet that any retail investor who plough into such a structure will be buying their fund managers yachts.

Yes but they will pay 2 & 20 to the managers in the different asset classes. Their participation will be as a Limited Partner in Limited Partnerships, and they will pay the full fees (less any discounts they can negotiate). I don't believe they have in house direct investing teams in Real Estate, Infrastructure and Private Equity (nor hedge funds): the big Canadian pension funds like Ontario Teachers (180.5 billion dollars), and OMERS (85bn) do.

So the fees are lower than a fund-of-funds but not than any other institutional investor investing in those asset classes.

[

[*]Access. Yale is not investing entirely in a portfolio of public equities. In public markets, the ability to access management both for information and to have a hand in governance is next to nonexistent. In private equity investing, good managers can actually add value to their own investment by participating in governance.[/list]

So goes the theory. The evidence says the top quartile outperform, handsomely. Larry Swedroe here has posted endless links to research that shows the average one probably does not-- if we compare to an equivalently geared S&P 500 or (better) Small Cap Value Index (for LBO funds). Swensen himself has written about venture funds. The Partnerships of about 10 firms extract all the excess value (and then some) in the industry-- the rest, you'd be better off in the NASDAQ.

What has historically been the case with Yale is that Swensen and his team have picked the *right* managers: for all of their different asset classes. They are good at picking third party managers.

According to the report, Yale has beaten the median endowment, as measured by Cambridge Associates, by 5.2 percentage points per year over the past two decades. During that same period, nearly 80 percent of Yale’s success relative to the average endowment was attributable to the value added by the university’s active managers, while only 20 percent was the result of its asset allocation.

The university’s strategy is to place skilled active managers in less efficient markets to add value to their investment and reap greater variability in return

So, yes, Yale can crush stock indices. However, you are not Yale. You do not have access to the same investing opportunities as does Yale. You do not have the same tax advantages as does Yale. So therefore, you are far less likely to be able to “crush” those stock indices as is Yale, as Yale’s tailwinds are your headwinds. And anyone who claims they can give you the same advantages as Yale for the low, low price of 2% of assets under management, and 20% of gains over a benchmark, is full of stercus vaccae.

Do people really quote those kinds of numbers in the US retail market ie fees of 2 & 20? Where low cost index funds are available and even active manager fees are much lower?

The individual investor cannot duplicate Yale for all the reasons you give. We don't have access as a LP to PE/ Infrastructure/ RE funds, nor Yale's manager selection skills. And the tax would kill returns.